| Author | Source |
|---|---|
| u/Bye_Triangle |
| [Education đ¨âđŤ | Data đ˘](https://www.reddit.com/r/Superstonk/search?q=flair_name%3A%22Education%20%F0%9F%91%A8%E2%80%8D%F0%9F%8F%AB%20%7C%20Data%20%F0%9F%94%A2%22&restrict_sr=1) |
THIS IS PART 2, SEE PART 1 HERE:
THE BROKEN PART FALLACY
Jack
Dave
Iâm more of the belief that these are complex systems. Itâs kind of a fallacy to just assign a broken part. So when a plane crashes, and they say, oh, this part of the wing failed, thatâs why the plane crashed. Right?
So in the flash crash, they said oh this guy was spoofing markets, and thatâs why the market crashed. But thatâs not how nonlinear systems work. Thatâs how linear systems work.
A causes B causes C, but in nonlinear systems, thatâs not how it works, there are, itâs an emergent property of a self-organized system I mean I you can go down a rabbit hole with, with this kind of systems theory and complexity theory, but Iâve written a bit about it but I think that assigning that sort of A causes B is not correct because youâre gonna have the exact same conditions happen another time and you wonât have a flash crash, because thatâs how nonlinear systems work you canât quite explain it in the same sort of framework that weâre used to.
Thereâs the reason that the spoofing had that effect was because of years of regulation that have removed diversity from the markets and led to a latency race and that have fragmented markets across multiple exchanges
itâs sort of environmental and regulatory and legislative and then thereâs also potentially a precipitating event, which is somewhat spoofing, but thatâs not necessarily the cause.
TL:DR đŚ Summary:
Non-linear systems are not easily explained. Just because 1+1 = 2 is simple for apes to understand does not mean that this is the case for HFT systems.
Complex,Non-linear systems as designed and described by Dave, ultimately are incredibly sensitive, and any number of factors can lead to flash crashes, not just manipulation, but this too isnât out of the question.
Boiled down, not even regulators can predict the impact that changes on these systems may have, and history shows that it can be extreme.
FLASH CRASHES
Jack
Dave
So it doesnât have to be manipulative, when we think illiquidity contagions or flash crashes are like the things youâve described sometimes itâs just them pulling out.
Right? So, if 90% of the quotes in the market are from HFT firms some sometimes as high as 99%, and suddenly the volatility increases, or they take on too much inventory, and they need to stop trading, which is a lot of what happened during the flash crash proper in 2010, theyâll just stop quoting, and as soon as they stop quoting suddenly that liquidity just starts disappearing, and other systems, key on that and then they start pulling out and itâs this positive feedback loop.
So, I mean maybe. Iâm not dismissing the possibility of manipulation because I see manipulation in markets, but sometimes itâs also just sort of this feedback loop that gets away from itself.
TL:DR đŚ Summary:
Jack mentions to Dave that GME has seen many events that could be considered a âflash crash, such as the March fall in price from $345 to $173.
Dave clarifies that crashes such as this may not be inherently manipulative, in that algos are just trading as designed. When 90-99% of the liquidity of a stock is provided by HFT systems; in the event of an increase in liquidity occurs or when HFTâs determine they hold too much inventory, they may be programmed to âpull outâ which can cause a snowball effect on other systems and crash the price.
Notwithstanding the above, Dave does not discount that manipulation is an impossibility at all, but thinks it is important to recognize HFT systems can act on a positive feedback loop as described.
ORDER TYPES, NOT SO SIMPLE
Jack
Interesting.
Letâs talk about order types, so personally, Iâve written a bit about order types before and basic market structure and the Wall Street Code which was a documentary that youâre a part of the mentioned earlier, started to peel back some of these layers in regards to order types and HFT traders getting certain advantages over others.
Iâm particularly interested in the conflict of interest between exchanges and the non-retail side, and how there isnât any equality there. Why not provide retail with the exact same options as they do non-retail? Can I get your thoughts on that?
Dave Lauer:
Dave Lauer
So you can see, kind of how crazy this is right? As I said on Reddit, itâs not Limit and Market. I was actually trying to post this picture but I couldnât quite get it to work in the comments.
So, hereâs an
âAdd Liquidity Only Midpoint Passive Liquidityâ order
Youâve got an âInter-Market Sweep Post No Preferenceâ order
âDisplay Limited Attributable Non-ISOâ
âInter-Market Sweep Post No Preference, Immediate or Cancelâ
I mean, these are very complex order types. Most of them are many of them are often dictated by the biggest customers of the exchanges, which are those HFT firms
And itâs not just retail that doesnât make use of them. Often, large broker dealers trading for institutional firms donât make use of them the way they should.
That has started to change.
Do you know what an âAdd Liquidity Only Post No Preference, Blind Orderâ would do? Because, not even NASDAQ knew what it would do, NASDAQ got fined because they had some crazy complex order type that was messing with the priority in a way that they had not even imagined.
That was discovered, and self-reported but itâs likeâŚÂ That is complex things have gotten.
So yes, the order types do advantage certain firms. and thereâs no way around it. Part of that is again because of regulatory conditions like reg NMS, which has forced exchanges to connect to each other, and to provide the functionality to route to each other. Or to bypass that routing with these ISO orders because reg NMS said that if thereâs a price in the market, on a protected quote, that is better than the one on the exchange your sending the order to, you have to go take that price on the other exchange.
Itâs led to a huge amount of complexity.
I think things would be a bit better if the market were simplified. I think the market markets would be better with fewer exchanges, non complex order types.
I donât know if much of this complexity is as beneficial as the costs of the complexity.
Youâll never get access to that for most retail brokers because most retail brokers are not sending orders to exchanges, sometimes theyâll, they will send limit orders to exchanges, but theyâll send it generally to whatever exchange will pay them. The highest rebate.
You need to use a broker who would provide access to certain to these types of order types.
So the only one Iâm familiar with is Interactive Brokers, versus some of the other retail brokerage platforms. I havenât used a ton of the active trader platforms on the other discount brokers⌠So, maybe they do, maybe they donât.
Many of them, for example wonât even route to IEX,
Which if youâre posted on IEX with a delimit order or a delimit midpoint peg, youâre getting similar functionality to what HFTs get.
But of course, I am biased, I worked with the guys at IEX. I know them, I have owned equity in it, But I did so because I believed in it. I thought it was a good solution to the problem.
TL:DR đŚ Summary:
The markets are becoming so over complicated with all these different types of orders, that not even the exchanges can keep up.
NASDAQ has been fined in the past for not being able to keep up and understand the orders on their exchange.
PAYMENT FOR ORDER FLOW
Jack
Thatâs a good transition into the Payment For Order Flow (PFOF) side of things. So, itâs no secret that RobinHood has kind of been popularized in this space, especially given their disclosures to customers last year getting started getting fined 65 million or so, but actually not quite understand
What are some of the negatives that come out of that from the retail side? Also the impact on the market as a whole, due to PFOF?
Dave Lauer
Dave Lauer
Reading from screenshot
These are obviously statements made before Citadel engaged in payment for order flow or before Jeff Sprecher, I think opened an IV. That was more recent than he bought it.
I think the payment for order flow and the internalization of retail orders is terrible for markets, and the thing about retail order flow is itâs referred to as âuninformedâ, that doesnât mean that you donât know where GME is gonna go in six months or a year. You might have the best fundamental analysis in a long time-horizon. You are not informed about what is going to happen in the next 50 milliseconds.
When you think of uninformed order flow it means, what is about to happen in the market as far as a high-frequency trading firm is concerned. And at that time-horizon is measured in milliseconds⌠maybe seconds. because of that retail order flow is what market makers want to trade against, Itâs very profitable to trade against it.
Thatâs why these market makers pay the retail brokers for it because they want to get that order flow.
An interesting paper just came out that showed that the impact on markets is significant. That when you take that profitable order flow and you donât let it get to exchanges and interact with other orders on the exchange, you can be affecting the spread by as much as 25%, maybe more, but, but at least what they could quantify they saw that spreads would tighten by 25% if that order flow made it to markets, and then, everyone benefits.
So we, we think, and I know, Reddit here thinks retail is active day traders trading through a discount broker, but I usually like to say that in fact, retail is the wealth of the nation or the wealth of the world it is mostly concentrated in mutual funds and pension plans. So you might have a small trading account that youâre playing with, but your retirement. Some people, I mean, I know some of you have it locked up in GME.
but for some people itâs, itâs in a mutual fund in an IRA or something, or 401k like that. And, and, to me, those are the refund to the ship, access to trade against retail orders on the exchange, like the rest of the world does.
I think that this is an area thatâs going to get a lot of attention. Some bills are being unveiled in Congress that could completely change this I very much support. And I think that I am in favor of competition. So like I said, there are many times where I am a capitalist I believe in intelligent capitalism and well-regulated capitalism but capitalism nonetheless. I believe in open competition for order flow Get the orders on the exchange and let every hundred of market makers should be able to compete over that order flow, not just the developer.
TL:DR đŚ Summary:
PFOF is more trouble than itâs worth.
It has been shown that PFOF can be affecting the spread at much at 25%
It is very profitable for a large firm to trade against/ ahead retail orders. I am speculating here, but this is likely why this is such an important fight for Citadel. We, the customer, are actually the product, just like with social media
DARK POOLS, INTERNALIZERS
Dave Lauer:
Along the lines of internalization and dark pools, I know that has been an area of a lot of questions on Reddit.
This morning, actually I put a couple of charts together that I wanted to show.
So, just to divert briefly. I want to talk about dark pools versus internalizers.
Dave Lauer:
These are two different things.
And you can see that FINRA has an excellent website, the OTC transparency website and you can see on the website:
ATS (Alternative Trading Systems): those are dark goals; versus
OTC (Over the Counter): those are internalized.
Dave Lauer:
So here is GME last November (2020). a certain percentage is getting executed on exchange and a certain percentage is getting executed off-exchangeâ
Of the off-exchange volume, 89% of it in November was OTC (think Citadel).
Versus March (2021), 87%.
So not much change since 2020.
Most GME volume is getting executed through retail channels and is being executed on the OTC market.
So when you think âdark poolsâ, the thing about, and where one of the confusion might lie, is when a trade executes off-exchange either OTC or in the ATS, it is still printed to the tape to whatâs called the trade reporting facility.
Dave Lauer
And I have up here, the market share.
Generally, in the market of the lit exchanges, all these are lit exchanges versus one of the TRS, one of the trade reporting facilities, this oneâs NASDAQ
for some reason, NYSE got cut off of this chart
but there is an NYSE TRF that was something like 7%
So what that showed was 40% of volume was executed off-exchange reported to the TRS
So every time Citadel internalizes a trade, it gets printed publicly, every time, Goldman Sachs or Morgan Stanley, or JP Morgan execute a trade in their dark pool, it still gets printed publicly.
You donât know who was the aggressor or anything like that but you know the quantity and the price that is executed at.
Dave Lauer
So now if we go back quickly to ATS versus OTC.
What I wanted to show was even though nothing has changed much in terms of where the trading is taking place, even a little less OTC but thatâs probably just normal statistical noise.
What has changed is whoâs trading on the OTC market.
Dave Lauer
So in November, it was predominantly Citadel with a little Virtu and an even little more G1X
This is market share, you can see that accounts for almost 85% of all OTC trading, and the rest is a bunch of smaller internalizers
And then it peaked for Citadel in January
But what weâve seen since then is actually Citadelâs market share in GME has dropped significantly and so has G1X, and Virtu has really taken over
At the same time, the average trade size thatâs being executed OTC has plummeted.
This was honestly really astonishing to me.
I guess this is probably the Robin Hood effect or the retail effect.
But you can see in December, the average trade size for Citadel was relatively high, it was around 350 shares and for Virtu it was around 200, and a little over 250 overall.
And since then in January, I mean, these, these dropped to under like 40 shares average trade size. That was really shocking to me. Part of that has been the price increase, absolutely.
But at the same time like an average trade size of 40 shares is extremely small. I donât know what to make of it necessarily but I thought it was an interesting sort of data point to highlight. I just wanted to show that.
Jack
Dave Lauer:
No, so this is: how much are they trading off-exchange, but this is just OTC, not ATFâ not dark pool. But I donât think Citadel is a material part of the ATS trading in GME.
I looked at it briefly and I saw a lot of it was Interactive Brokers so when they internalize theyâre printing on an ATS, not OTC, and they invite other firms to come into the ATS.
Thatâs one of the differences when youâre trading or printing OTC versus plugging ATSs.
Other firms can trade in a dark pool, whereas OTC theyâre not.
Jack
Dave Lauer:
Yeah, Iâm not sure of the mechanism for how that would work, because like I said, even if youâre trading in a dark pool that trade is printing to the tape.
I think that if you canâ I mean, technically you canât know that there are offers on the dark pool. Thatâs why itâs called Darkâ thatâs the whole thing.
So, if thereâs this wall of offers at 180, youâre getting all these orders coming in on your retail channel and you want to keep it from going over 180 for whatever reasonâ
Iâm not sure of the mechanism that you would use to print that off-exchange.
I think from that perspective, I am sorry to say, I didnât find that analysis to be compelling, and I could be wrong, but I think:Â you donât need the dark pools in that equation you can:
layer orders in the market;
internalize it,
because when youâre internalizing orders youâre internalizing them within the NBBO which you donât necessarily control.
But if you want to control it, you have to do that on the lit market, not in the dark pool.
The dark pool, legally, can only execute within the NBBO.
Jack:
I think thatâs kind of where that came from, but they have that restriction of executing within the NBBO, it doesnât really have that, is that right?
Dave Lauer:
No, it does and itâs absolutely true that institutions use dark pools.
If I want to buy a million shares of GME. it would be a big mistake if I just hit the market with a million shares, right?
Iâm going to really, Iâm going to exhaust all of the standing offers that price is going to go crazy.
Thatâs not getting the best execution.
Instead, if I want to buy a million shares first Iâm probably going to send maybe half a million to one broker half million to the other, theyâre going to take that half a million and sit them in their dark pools, so that nobody knows theyâre there but if sellers come along, then theyâre going to hit my bids and Iâm going to start buying little by little and then those brokers are also going to algorithmically be routing them all over they might be pinging Citadel and pinging Virtu and others.
Dave Lauer
This slide shows you the complexity of the market, right?
This is what Iâm doing, I am trying to navigate this complexity, to get the best price that I can while leaking the least amount of information possible.
if I were just to post that giant order on the lit exchange, thatâs complete information leakage. So thatâs a very good and reasonable use of dark pools. But again, you cannot trade outside of the NBBO. That is the rule in US markets - Rule 611 I think.
Itâs the backstop for best execution is whatâs generally referred to as. You cannot get outside of the protected quote.
Jack:
Dave Lauer:
And Iâll be happy to read some of the posts and if there are specific questions.
Iâm always interested in learning more, I mean if thereâs a mechanism by which someone thinks theyâve figured out how they can suppress the price through dark pools, Iâd be really interested in that, because it would directly impact some of the analysis that I do.
IEX
Jack:
So, one last question I want to end on is, where does IEX fit into this?
So from our perspective, a lot of the features that were built on IEX were built to benefit more of the mutual fund side of things.
And then Iâve seen recent talk about retail coming along.
Could you help describe some of the positives at IEX works for retail?
Dave Lauer:
Yeah, so for retail, you can get mid-point executions on IEX. Itâs free for retail trade on IEX. Theyâve really tried to do what they can to incentivize the retail brokers to come to them.
It doesnât mean that they are, because there are really fundamental conflicts of interest at work in markets in terms of payment for order flow and other issues.
you can tell your brokers, and you should tell your brokers, if you want to trade on IEX, and that they should route to IEX
When Flash Boys came out, it created a real uproar, and it helped to a certain extent but then it died away. Maybe now this is the second wave of it.
Look, I wouldnât have gotten involved with IEX if I didnât believe what theyâre doing.
Iâm not involved in any way with them anymore, other than that, I still have some shares leftover. I donât want to not disclose my biases, I mean I sit on the board of Equitoss in Canada which also has a speed bump and it also is designed for investors not high-speed trading firms.
So I believe that is a model that can work and can protect investors.
Iâve seen one of the questions: What was the original design goal of IEX?
And the philosophy was actually relatively simple:
the exchange should always be faster than the fastest participants, the exchange should always know what the price is in the market.
if that price is changing, the exchange should know about it before, the highest speed participants know
And the reason really came down to pegged order types.
If firms are faster than the exchange, they can take advantage of pegged order types, and they can pick off stale orders for a relatively low-risk arbitrage.
Whereas, if the exchange is faster than its fastest participants, that repricing for peg order types will always happen before those high-speed firms can adapt and pick off stale order types.
So that was why the 350-microsecond speed bump was put in place because that seemed like a good time for the exchange to be able to receive market data from all the other exchanges, update its price, and shift before other firms could come in and pick off stale prices.
I think that kind of protection is valuable, I think execution quality in IEX is very high, and weâve seen the same thing in Canada with Equitas Neo.
Iâm a believer in the model. Iâm a believer in the idea that you shouldnât offer rebates to attract liquidity and IEX does not do that.
I believe that if you believe those things, then supporting IEX is worthwhile and that you can go to your brokers and you can give them instructions.
And brokers, according to FINRA rules 5310 (I think), have to abide by those instructions. Not all brokers will, theyâll say weâre not connected or we donât do that but if they start hearing from a lot of people that can help to change things.
TL:DR đŚ Summary:
IEX has a lot of functionality that can make for a better retail trading experience.
If IEX is something that you are interested in trading on, then contact your broker and let them know
WHAT CAN WE DO?
Dave Lauer
There have been questions about what can we do and to me this is one of those things that we can do.
Another thing is you can just continue to make your voice heard, you can file comment letters with the SEC or FINRA, thatâs an excellent way to get involved, they do read them and they do listen to well thought out comments, or well-researched comments.
You can contact your members of Congress because these bills that are going to come up are going to be controversial and they need to hear that there are people out there that support them, for good reasons.
You can make use of the SEC and Office of the Investor Advocate who is there to advocate on your behalf and is often focused on institutional investors but would probably like to hear more from retail.
And Gary Gensler I think in his testimony before Congress is going to say that theyâre requesting public input on some of these exact issues.
So I think getting involved like that is just an excellent thing.
Itâs great to have more involvement and more perspectives in this market structure debate, versus most of the people that are involved generally work for the high-frequency firms, the exchanges, the broker-dealers
There are very few of us out there who are not beholden to one of those types of firms and who are making money, actively, off of the current market structure.
TL:DR đŚ Summary:
MAKE YOUR VOICE HEARD
FINAL QUESTION AND GOODBYE
Jack
The last question, I swear, and then weâll wrap up.
So you just mentioned that the rule is to uphold the NBBO. But what happens when they donât, is it actually possible that they donât uphold that rule?
Dave Lauer
So, yes, there is a percentage of trading that does take place outside the NBBO.
That can happen if the size at the NBBO is not enough to satisfy the order size.
So yeah, I shouldnât say that it never happens, it does happen under those conditions.
But generally speaking, it does not happen outside of those conditions
So maybe what youâre thinking: If you see a dark pool print, and itâs like off the NBBO, there is a reporting deadline, I think it was shortened to 10 seconds, which means that I can trade at this price, and now prices have shifted, I have 10 seconds to report to the tape so the problem is sometimes the trading feeds from the dark pools is not always aligned with the quote feed from the exchanges.
It can look sometimes like there are prints that are happening outside of the NBBO but that didnât actually take place.
It is a pretty serious thing.
I know that FINRA gives report cards to firms measuring their Rule 611 performance, and they are always looking to see if you are trading outside the NBBO, and when itâs a very small percentage of the time that happens, and when it does, thereâs usually a reason behind it.
Jack
Dave Lauer:
Well, I mean, most fines are unfortunately just slaps on the wrist.
Thatâs sort of the corruption inherent in the system, the Revolving Door which we havenât even touched on, and kind of is the source of most of these problems.
But yeah I mean fines on Wall Street are generally nothing compared to the damage that theyâve caused, and most of the time is just seeing that the cost of doing business.
And I think we just see that over and over again in every way, whether itâs the great financial crisis or the mortgage crisis, to test execution violations.
These kinds of issues, and even their best execution is hard to enforce.
I heard the quote from a regulator that trying to enforce the best execution is like trying to nail jello to a wall.
Itâs something that they really struggle with and itâs a shame because you have so much data now that from a data science perspective it should actually be easier but you need a different level of sophistication to analyze that kind of data.
I think regulators have struggled with it
So thatâs my soapbox of: increase the fines and send people to jail and I think you would see dramatic changes in behavior.
As long as itâs just the cost of doing business and not, not speaking specifically to trades outside the NBBO, because again I donât think that happens much.
But generally speaking, when firms are fined it doesnât recognize the damage or it often doesnât disgorge profits to the extent that it should.
Jack
Dave Lauer:
Jack:
And thanks to all the viewers for coming around and spending time with us.
Dave Lauer:
Thanks for having me, I appreciate it. I loved it.
People care about this, itâs fun to talk about it.
PHEW That was an action-packed AMA⌠ending right at 69 minutes (Good Job u/jsmar18). I hope that you guys are finding these AMA transcript/summaries helpful, they are a lot of work to put together but it feels worth it.
âIâM HELPINGâ
If you have any feedback for what you would like to see in these, let us know! I may not respond to every comment, but I am definitely reading most of them.
Cheers,
B_T